Federal Reserve Under Jerome Powell's Leadership Faces Renewed Expectation of Treasury Yield Curve Widening

Fed Chair Vote Looms, Wall Street Strategists Predict Shift in Treasuries Market

The $31 trillion Treasuries market is bracing for a potential shake-up as Kevin Warsh, a former Fed governor, faces a vote this week to succeed Jerome Powell as the central bank's chair. Wall Street strategists believe that a Warsh-led Federal Reserve may jolt the market out of its narrow trading ranges, urging investors to position for shorter-dated yields to eventually move lower.

US yields rose two to three basis points on Monday, staying on pace for their tightest monthly range since late 2020. The 10-year yield was up three basis points to 4.33%. This low-volatility environment has strategists looking ahead to longer-term catalysts, particularly as the Federal Reserve is widely expected to keep interest rates steady this week.

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Morgan Stanley strategists led by Matthew Hornbach expect a Warsh-led Fed to target new inflation metrics, provide markets with less forward guidance, and push for a smaller balance sheet, which "may lift meeting-to-meeting volatility." They, and others on Wall Street, expect a boost to shorter-dated yields and a revival of the so-called curve steepener trade.

The bond market is currently holding roughly steady after slumping last month. Elevated oil prices have been seen posing a risk to inflation that, if sustained, could ultimately hurt growth and slow the economy. Money managers will monitor Powell's comments at this week's meeting for any clues on how the central bank is assessing the economic impact of the war.

Traders are leaning toward a reduction by the end of the year, pricing in eight basis points of a quarter-point cut by the December meeting. Rate reductions are often seen bringing down front-end yields and helping steepen the gap out to longer-term, 10- and 30-year maturities.

Fed officials "are going to try and buy time as they are seeing a pretty strong economy, above-target inflation," said Robert Tipp, head of global bonds and chief investment strategist at PGIM Fixed Income. "They're going to want to avoid shocking the markets and creating an inadvertent tightening of financial conditions."

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For now, he sees shorter-maturity Treasuries at risk depending on the read-through from the conflict into economic data. Investors will watch a reading of the Fed's preferred gauge of inflation on Thursday. Already this week, the slightly weaker tone in the market helped entice bidders for sales of $69 billion of two-year notes and $70 billion of five-year notes. A $44 billion auction of seven-year notes is due on Tuesday.

"We have a rare combination of Iran-US headline drivers, economic data and major earnings releases this week, any of which can shake things up," said Jack McIntyre, portfolio manager at Brandywine Global Investment Management. "The bar is high for the Fed to jawbone market expectations one way or the other."